Markets Are Exuberant As Central Banks Head for Rate-Cut Mode

The Fed’s counterparts at the European Central Bank and the Bank of England similarly signaled lower rates ahead, while the

Swiss National Bank

made a surprise cut this past week. Although the

Bank of Japan

finally exited negative interest rates, monetary conditions there remained lax, with zero rates and a weak yen. Meanwhile, major Latin American central banks, led by Brazil and Mexico, are well along in their rate cuts, having been much prompter in raising their rates to fight inflation starting in 2021, a year or more ahead of the Group of 10.

As expected, the Summary of Economic Projections that came out of the past week’s meeting of the Federal Open Market Committee confirmed that monetary authorities continue to look for three one-quarter-percentage-point reductions in their federal-funds target by year end, from the current range of 5.25% to 5.50%. That was the same median projection as in December. It also was in line with futures market forecasts, which have come into line with the Fed’s thinking. Early in the year, markets were anticipating six or seven reductions.

The FOMC median projections for three cuts by December remained even while the panel revised upward its median guesses for 2024 economic growth and inflation, while lowering its projection for unemployment. Gross domestic product now is anticipated to be up 2.1%, measured fourth quarter to fourth quarter, versus 1.4% in December. The core personal consumption expenditures index, which excludes food and energy, is expected to rise 2.6% this year, up from 2.4% previously. The year-end jobless rate now is projected at 4.0%, down from 4.1% previously.

Federal Reserve Chairman Jerome Powell characterized the higher inflation numbers as the result of “bumps” in the January and February data. Not too much weight should be given to those bad data, just as he said not too much should have been made of the preceding months’ more moderate increases. He maintained the Fed would go slow in easing policy until the monetary authorities were confident inflation was on a steady path to their 2% target.

“Policymakers really, really, really want to cut rates, and it is not a matter of if but how soon,” write Mizuho Securities economists Steven Ricchiuto and Alex Pelle in a client note.

June seems to be the most likely time for the initial reduction, with approximately a 75% probability, according to the CME FedWatch site.

The revisions in the FOMC’s economic outlook, which showed more robust growth and higher core inflation, lowered the bar for Fed rate cuts and boosted investors’ appetite for risk assets, notably stocks, they added. That has consequences for the real economy. “The more accommodative financial conditions become, the more the economy is likely to surprise to the upside and the tighter the labor market will get,” they point out.

With the S&P 500 up 33% and home prices up 6% from a year ago, Evercore ISI’s economics team, led by Ed Hyman, reckons consumer net worth is up 9% in the first quarter from a year earlier. Its proprietary survey of Realtors also shows robust home prices. “It would be unusual for a recession to start with house prices this strong,” a client note says.

Against this backdrop of exuberant financial markets and firmness in the credit-sensitive housing market, the Fed nonetheless sees the need for easier monetary policy. Powell suggested at his post-FOMC news conference that financial conditions were tight. That presumably was based on relatively high real interest rates across the Treasury market, writes Jonas Goltermann,…